Question

As the director of capital budgeting for EFG Corporation, you are evaluating two mutually exclusive projects with the following net cash flows:

Project E Project F

Year Cash Flow Cash Flow

0 -$100,000 -$100,000

1 50,000 10,000

2 40,000 30,000

3 30,000 40,000

4 10,000 60,000

If EFG’s cost of capital is 15 percent, What is the NPV and IRR of the better project, respectively??

Answer 1

To determine which Project is better, we will compute the NPV of both the projects. The Project with higher NPV will be better.

Computation of NPV of Project E and Project F

Year	Project E	Project F	PVAF @15%	PV- Project E	PV- Project F
a	b	c	d	e=b*d	f=c*d
0	-$100,000.00	-$100,000.00	1	-$100,000.00	-$100,000.00
1	$50,000.00	$10,000.00	0.869565217	$43,478.26	$8,695.65
2	$40,000.00	$30,000.00	0.756143667	$30,245.75	$22,684.31
3	$30,000.00	$40,000.00	0.657516232	$19,725.49	$26,300.65
4	$10,000.00	$60,000.00	0.571753246	$5,717.53	$34,305.19
			NPV	-$832.97	-$8,014.19

NPV of Project E (i.e. -$832.97) is higher than Project F (i.e. -$8014.19). Therefore, Project E is better.

Calculation of IRR of Project E-

IRR is that rate of return where PV of cash inflow = PV of cash Outflow

Using hit and trial method, we get IRR= 14.5% (this is the rate at which PV of cash inflow is approximately equal to PV of cash outflow).

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